****

**SFFAS 54 LEASE GUIDANCE:**

**RIGHT-TO-USE LEASES:**

**DEEMED “CAPITAL LEASES” FOR BUDGETARY TREATMENT**

**EFFECTIVE FISCAL YEAR 2024**

**PREPARED BY:**

**GENERAL LEDGER AND ADVISORY BRANCH**

**BUREAU OF THE FISCAL SERVICE**

**U.S. DEPARTMENT OF THE TREASURY**

**RIGHT-TO-USE LEASES GUIDANCE: BUDGETARY CAPITAL**

**Effective Fiscal 2024**

                                                                                                                                  Page 40 of 41                                                                                              November 2022

**Proprietary Accounting Requirements & Agency Decision Points**

SFFAS No. 54, *Leases*, as amended by SFFAS No. 60 and SFFAS No. 61, replaces proprietary lease accounting and disclosure standards for general purpose federal financial reports. SFFAS No. 54 is effective for reporting periods beginning after September 30, 2023. (Early implementation is not permitted.)

A lease is defined as “a contract or agreement whereby one entity (lessor) conveys the right to control the use of PP&E (the underlying asset) to another entity (lessee) for a period of time as specified in the contract or agreement in exchange for consideration.” (SFFAS 54, Par. 6.)  SFFAS No. 54 requires that federal lessees recognize a lease liability and a right-to-use lease asset (also referred to as a lease asset), and that federal lessors recognize a lease receivable and unearned revenues at the commencement of the lease term, unless the lease meets the definitional criteria of a short-term lease, contract or agreement that transfers ownership, or an intra-governmental lease.

For proprietary accounting, entity management is responsible for exercising professional judgement and collaborating within its agency to reach certain determinations before establishing proprietary accounting treatment, including:

**1)** Lease Term, with consideration for Options, Renewals/Terminations, and Cancellation Clauses; 

**2)** Calculation of Lease Asset/Liability; with consideration for Fixed vs. Variable Payments; 

**3)** Selection of Proprietary Interest Rates - Amortization of Discount on Lease Liability/Receivable; 

**4)**Modifications, Terminations, and any respective remeasurements; and

**5)**Contracts or Agreements Containing Nonlease and Lease Components (if applicable)

**Proprietary Lease Term**

For proprietary accounting, calculating the lease term is pivotal because the classification between short-term leases and right-to-use leases depends on the lease duration. The lease term is determined to be the noncancelable lease period, plus certain periods subject to options to extend or terminate the lease. The noncancelable period is the shorter of the period agreed upon in the lease contract that: **(1)** precedes any option to extend the lease; or **(2)** precedes the first option to terminate the lease.  In addition, the lessee’s lease term should include the noncancelable period, along with periods:

· Involving an option to extend the lease, if it is probable that the lessee or lessor will exercise that option (SFFAS 54, Par. 15a & 15c)

· Following an option to terminate the lease, if it is probable that the lessee or lessor will not exercise that option (SFFAS 54, Par. 15b & 15d)

Some specific provisions may also need to be applied when determining the lease term:

· Periods for which the lessee/lessor **(1)** have an option to terminate the lease without permission from the other entity, or **(2)** have to agree to extend, are considered to be cancelable periods and are thus excluded from the lease term (SFFAS 54, Par. 19a.)

· An availability of funds/cancellation clause allowing lessees to cancel a lease agreement if funds for the lease payments are not appropriated should only affect the lease term when it is probable that the clause will be exercised (SFFAS 54, Par. 19c.)

· If a lessee has the option to purchase the underlying asset during the lease term and the contract is not a contract that transfers ownership, the lease term should exclude the period, after the date at which the option is probable of being exercised (SFFAS 61, Par. 6)

**Calculating the Lease Asset/Lease Liability Amounts: Fixed vs. Variable Payments**

The Lessee’s lease asset and the Lessor’s lease receivable should include the present value of payments expected to be made during the lease term.  Generally, these should include:

· Fixed payments;

· Variable payments that depend on an index or a rate;

· Variable payments that are fixed in-substance; and

· Any lease incentives receivable from the lessor.

For a complete list of payment types to include in the present value of payments, please see SFFAS 54, Paragraphs 40 and 56. (SFFAS 54, Par. 49 also identifies costs that are to be capitalized as part of Lessor’s lease asset that are not components of a Lessee’s lease liability.)

Variable payments based on future performance of the lessee or usage of the underlying asset should be recognized as lease expense/revenue during the reporting period to which those payments relate.  These variable payments should not be included in the measurement of the lease liability/lease receivable.  (See SFFAS 54, Pars. 41 and 54.)  Reporting entity management should consult with appropriate procurement officials, and use professional judgment, to make determinations on what payments are fixed and what are variable for proprietary lease accounting purposes.

**Proprietary Interest Rates - Amortization of Discount on Lease Liability/Receivable - Interest Expense/Revenue**

Future lease payments should be discounted using the interest rate the lessor charges the lessee. When the rate is not stated in the lease, SFFAS 61 allows agencies flexibility to use a rate based on a recent marketable Treasury security rate, or a historical average interest rate on marketable Treasury securities of a similar maturity to the term of the lease: “If the interest rate is not stated in the lease, the interest rate should be based on the interest rate on marketable Treasury securities at the commencement of the lease term (or at the subsequent financial reporting date), with a similar maturity to the term of the lease.” (SFFAS 61, Par. 6) Methodology for selecting interest rates based on marketable Treasury securities should be documented and should be consistent from period to period.

In subsequent reporting periods, the Lessee should calculate the amortization of the discount on the lease liability and recognize that amount as interest expense for the period. Any payments made should be allocated first to the accrued interest liability and then to the lease liability. (SFFAS 54, Par. 43)

Likewise, the Lessor should calculate the amortization of the discount on the receivable and report that amount as interest revenue for the period (SFFAS 54, Par. 60.)  

**Lease Amortization & Lessor Unearned Revenue**

During the lease term, the Lessee’s lease asset should be amortized in a systematic and rational manner, over the shorter of: The lease term; or the useful life of the underlying asset.  Meanwhile, the Lessor should amortize the unearned revenue to lease revenue in a systematic and rational manner over the term of the lease.  (SFFAS 54, Par. 65)

**Modifications/Terminations**

In the event a right-to-use lease is terminated before the end of the contractual lease term (other than by a transfer of ownership/purchase of the underlying asset), a Lessee should account for the termination by reducing the carrying values of the lease liability and the lease asset and recognizing a gain/loss for the difference.  Likewise, lessors should reduce the carrying value of the lease receivable and the related unearned revenue, and record a gain/loss for the difference.

**Contracts or Agreements Containing Nonlease and Lease Components**

For contracts or agreements containing both nonlease and lease components, in which the purpose of the contract is primarily attributable to the nonlease component(s), entities may elect to apply the practical accommodation in SFFAS 62.  

This practical accommodation allows for the entity to treat the entire contact (including lease components) as a nonlease contract and to expense/recognize as revenue the lease payments, rather than recognizing both expenses/revenue and lease assets/liabilities following the provisions of SFFAS 54. (See SFFAS 62 for complete details on how to make the election, along with how to apply certain reporting and disclosure requirements.

Entity management must use professional judgement to assess the nature of contracts or agreements to make the most appropriate decision on the primary purpose of the contract.  (SFFAS 62, Par. 5)

**Budgetary Accounting Requirements & Agency Decision Points**

While proprietary accounting requirements for leases are transformed by SFFAS 54, *Leases*, budgetary accounting requirements will remain unchanged and continue to be guided by the lease scorekeeping rule developed by OMB, CBO, and the House and Senate Budget Committees originally in connection with the Budget Enforcement Act of 1990, and guidance regarding this rule provided in *OMB Circular No. A-11, Appendix B,**Budgetary Treatment Of Lease-Purchases and Leases of Capital Assets.*

For budgetary accounting, entity management is responsible for exercising professional judgement and collaborating within its agency to reach certain determinations before establishing budgetary accounting treatment, including:

**1)** Operating vs. Capital Lease (as defined by Appendix B of OMB Circular No. A-11); 

**2)**Budgetary Lease Term, with consideration for Cancellation Clauses;****

**3)**The Budgetary Interest Rate is selected per OMB Circular No. A-94, Appendix C guidance; and

**4)**Budget Authority and Outlays.

**Operating/Capital/Lease Purchase**

Reporting entities should apply professional judgment, consistent with the guidance in Appendix B of *OMB Circular No. A-11*, on Operating Leases/Capital Leases criteria to discern the correct budgetary treatment of each lease contract.  Budget Authority for Capital Leases should be recorded up-front in an amount equal to the “asset cost,” as defined in Appendix B.  Meanwhile, outlays of Capital Leases are scored over the lease term in an amount equal to the annual lease and other contractually required payments.      

“Amounts. The up-front budget authority required for both lease-purchases and capital leases is called the asset cost. This equals the present value of the minimum lease and other contractually required payments excluding payments for identifiable annual operating expenses that would be paid by the Government as owner, such as utilities, minor maintenance, and insurance. Property taxes will not be considered to be an operating expense and will be included in the calculation of the up-front budget authority. (See section 3 for the treatment of property taxes for purposes of distinguishing operating leases from capital leases.) Other contractually required payments include any and all costs related to the asset being leased in addition to the rent fee applied under the lease.

For example, other contractually required payments would include all costs under triple net or other unique arrangements. The present value of the lease and other contractually required payments is discounted as of the date of the first payment (or the beginning of the lease term, whichever is earlier) using the appropriate interest rate (see section 4 for a more detailed explanation and the treatment of multiple deliveries).”

**Listing of USSGL Accounts Used in This Scenario:**

**Key Assumptions Driving Proprietary Accounting Entries:**

**Lease Term**

· A federal reporting entity (Lessee) signs a 5-year lease with a non-federal entity (Lessor) for the right to control/right to use equipment.  (For illustration purposes, the scenario also shows posting logic under a separate heading for a federal Lessor working with a non-federal Lessee.)

· For illustration purposes, the lease is assumed to begin at the start of the fiscal year, **10/01/2023.**

· No purchase option probable of being exercised exists.

· The Lessor already has equipment on its Balance Sheet valued at $300,000 with $150,000 Accumulated Depreciation.

· The Present Value of all expected fixed payments is $100,000.  

· The Lessor charges the Lessee the Interest Rate on marketable Treasury securities as of the commencement of the lease term, per SFFAS 61 Paragraph 6 guidance, which for purposes of this scenario is assumed to be 10.00%.

· All monthly payments are made at the last business day of the month – This scenario assumes payments are made directly to vendor and that there is no lag time between disbursement, authorization, and receipt.

**Lease Asset/Liability Calculation**

· The contract amount is $120,000 ($2,000 monthly payments x 60 months.)

· Management calculates the Present Value of all expected fixed payments to be $94,131.  The Lessor charges the Lessee the Treasury Rate of 10.00%. 

· The Lessor already has equipment on its Balance Sheet valued at $300,000 with $150,000 Accumulated Depreciation.

**Fixed & Variable Payments**

· Management determines the lease contains only fixed payments.  Fixed payments include a minimum annual payment required by the lease contract, and lease payments (including interest) are paid at the start of the year.  

· Management determines there are no variable payments based on lessee performance or future usage of the underlying asset in the contract, per SFFAS 54, Par. 41. (Also See Technical Release 20, Lease Implementation Guidance, Par. 48 for more information on Variable Payments.)

· Management determines that the fixed lease payments are “contractually required payments" per *OMB Circular A-11, Appendix B*.

**Key Assumptions Driving Budgetary Accounting Entries:**

**Budgetary Authority**

· For illustration purposes, the lease is assumed to begin at the start of the fiscal year, **10/01/2023.**

· The Lessee received a direct appropriation and is working from a multi-year appropriated TAFS from a general fund expenditure account.  Agency management has concluded that appropriations language allows the budget authority to remain available for the lease and other contractually required payments over the full term of the lease.

· It is the responsibility of agencies to determine the correct discount rate and do their own calculations when determining budget authority for capital leases.  Per *OMB Circular No. A-11, Appendix B*, all assumptions required to perform the lease analysis are subject to OMB approval. (The differential cost of financing has to be paid upfront by the agency as part of their asset cost calculation.)

· The Lessor charges the Lessee the Interest Rate from OMB Circular No. A-94, Appendix C guidance, which for purposes of this scenarios is assumed to be 10.00%. Per OMB Circular No. A-11, Appendix B, all assumptions required to perform the lease analysis are subject to OMB approval.  

· Management determines that the fixed payments are "contractually required payments" per *OMB Circular A-11, Appendix B*.

· Note – For budgetary purposes, agencies will need to develop amortization tables to calculate the asset cost of capital leases.

**Budgetary Lease Capital/Operating Determination**

· Management determines the lease to be a “**Capital lease**” for budgetary purposes. Therefore, the asset cost (up-front budget authority required) is the present value of the minimum lease and other contractually required payments.  (Note that the differential cost of financing has to be paid upfront by the agency as part of their asset cost calculation.)

· Additional budget authority equal to the cost of financing (imputed interest cost) is recorded on an annual basis over the lease term.  Imputed interest cost is calculated pursuant to the guidance in *OMB Circular No. A-11*, Appendix B using the Treasury interest rates published in the most recent update to Appendix C of *OMB Circular No. A-94*.  It is equal to the difference between the minimum lease and other contractually required payments under the full term of the lease and the estimated net present value of those payments (asset cost) that is recorded upfront. For this example, assume the appropriate discount rate is 10.0%.

· There are no other payments for identifiable annual operating expenses (utilities, minor maintenance, and insurance, etc.)

**Budgetary Outlays**

· Outlays are scored annually equal to the annual lease and contractually required payments.  Over the life of the lease: 

· Outlays for the asset cost comes from the balances obligated when the lease agreement was signed; and

· Outlays for the imputed interest cost comes from new budget authority.

**Cancellation Clauses**

· The lease does not contain renewal/purchase options or cancellation clauses, and is not associated with government land.

**Proprietary Amortization Table**

· **Contract Amount $120,000**

· **5-Year Lease, 60 monthly payments of $2,000 each**

· **Interest Rate of 10.0% for Proprietary Accounting**

· **Present Value of Payments = $94,131**

· **Lessee Right-To-Use- Asset & Lease Liability amount: $94,131**

· **For illustration purposes, the lease begins at the start of the fiscal year, 10/01/23**

· **Monthly payments are considered to be disbursed on the last business day of each month.**

**Schedule of Budgetary Resources**

· **Year 1 Budget Authority = Up-front Budget Authority (Present value of the minimum lease and other contractually required payments over the full term of the lease), as well as the imputed interest accrued on the debt in Year 1.**

**$94,131 Lease Principal Payments over 5 years, plus Year 1 Interest Expense of $8,726 = $102,857**

· **Year 2 Budget Authority = Year 2 Interest Expense of $7,126 = $7,126**

· **Interest Rate of 10.0% for Budgetary Accounting.**

· **Budget Outlays correspond to the monthly fixed payments over the lease term.**

**Disclaimer**

The below guidance is intended to serve as a reference only based on a finite number of underlying assumptions.  It is in no way intended to provide comprehensive posting logic for every leasing activity.  Agencies should have a thorough understanding of authoritative standards SFFAS 54, SFFAS 60, and SFFAS 61, and apply other factors, including but not limited to certain prepayments, accruals, etc.  As stated above, agency management must exercise professional judgement and collaborate within their agency to reach determinations of lease activities on a lease-by-lease basis, before establishing accounting treatment.  

Budgetary and/or legal staff should ascertain the applicability of certain budgetary accounting terms from OMB Circular No. A-11, Appendix B, including but not limited to “contractually required payments.”

Entity management should document these decisions and incorporate them into management’s existing OMB Circular No. A-123, “Management's Responsibility for Enterprise Risk Management and Internal Control,” Appendix A, procedures.

****

**FISCAL YEAR 1 - Right-To-Use Leases; “Capital” for Budgetary Treatment**

**Lessee Accounting**

**Lessor Accounting – FY 1**

****(For simplicity, the recurring entries of Lessor Receipts for Months 7-12 are not illustrated, but amounts can be seen in the amortization table.)****

**Fiscal Year 1 Post-Closing Adjusted Trial Balance:**

**Year 1 Financial Statements:**

**Year 1 Reclassified Financial Statements:**

**FISCAL YEAR 2 - Right-To-Use Leases; “Capital” for Budgetary Treatment**

**Lessee Accounting – FY 2**

****(For simplicity, the recurring entries of Lessee Payments for Months 7-12 are not illustrated, but amounts can be seen in the amortization table.)****

**Lessor Accounting – FY 2**

**Fiscal Year 2 Post-Closing Adjusted Trial Balance:**

**Year 2 Financial Statements:**

**Year 2 Reclassified Financial Statements:**

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